If you thought the pulling away of tax saving funds from Section 80C was bad news, then it only gets worse. Now you pay a 5 per cent tax on dividend earned from all equity mutual funds.
At present, dividends earned from equity funds are tax free. Do note, you will not have to pay this tax directly, but it will be charged to the fund house. But make no mistake, it does impact your returns.
Let's say your fund gives a 10 per cent dividend (on the face value of a unit of Rs 10). That amounts to Rs 1 per unit. If 5 paisa goes towards the dividend distribution tax (DDT), you will end up only with 95 paise. This DDT will be paid by the fund house before it credits the dividend to you.
Let's drive the point home with another example. Let's say you hold 1,000 units of a fund which has announced a Rs 1 per unit dividend. Your total dividend would be Rs 1,000, the DDT amounting to Rs 50. The effective dividend (which is what you will get) would be Rs 950.
In case of debt funds, the dividend received would be added to the total income and taxed as per the income tax slab that the individual falls under. In such a case, the individual himself pays the tax, not the mutual fund.
How must investors adjust?
Shift to growth options
A mutual fund scheme comes with two options - dividend and growth. Under the dividend option, the fund house pays dividend according to the call of the fund manager, generally where there is sufficient appreciation in the assets. The net asset value of the fund comes down by a similar proportion as the payout post-dividend. In the growth option, the investor gets the total amount only at the time of redemption. Besides saving dividend tax, investors gain more from growth options due to the compounding effect (see table: Dividend Dilemma).
Worth noting here is that according to the new regulations by the Securities and Exchange Board of India (SEBI), dividends can only be declared from realised gains. Hence, pre-defining the frequency of declaring dividend in equity schemes is very difficult.
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Opt for an SWP on your equity fund
If you are on the lookout for periodic payments, opt for a Systematic Withdrawal Plan (SWP). This allows you to withdraw money from your fund according to a pre-decided schedule, basically the reverse of a Systematic Investment Plan (SIP). Depending on your need for a monthly or quarterly income, an investor can choose a withdrawal pattern. Alternatively, one can even opt for withdrawal only on capital appreciation, thus protecting the capital amount.
If this appeals to you, opt for an SWP only after the first year of the investment, as most funds levy an exit load on redemptions before completion of a year. In the case of equity funds, it also saves on short-term capital gains tax.
Opt for an SWP on your MIP
Monthly Income Plans (MIPs) are a regular source of income for many investors, especially retired individuals who park a part of their retirement corpus in MIPs and receive dividend payouts frequently. As MIPs come under the debt fund category, the dividend would now be taxed as per an individual's income-tax slab. Investors in MIPs should also consider SWPs instead of dividends to save taxes on them. Again, opting for an SWP after a year of being invested helps in saving the exit load. We illustrate (see table: SWP and Dividend) how much one can save on tax by opting for an SWP on a growth option instead of an MIP with a dividend option.
SWP and Dividend
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||